Is financial regulation holding back innovation in the UK? (blog)

Barely recognisable from the country whose economy was left crippled by the global financial crash of 2008, the UK has come a long way in eight years – today it stands as the world’s leading fintech centre.

Seemingly a hotbed of financial innovation, the UK is now home to a large number of Europe’s e-money firms and the industry here is thriving. In the hopes of capitalising on this success, the government has created an innovation plan to help further bolster the UK’s reputation as having the most competitive and innovative financial services industry in the world. The plan seeks to lower barriers to entry for new, innovative firms to enter the market, encourages more exploitation of new technology within the sector, and hopes to create a more effective regulatory environment.

However, while it may seem that ‘innovation’ is becoming synonymous with ‘success’ for some, it’s important to remember that this wasn’t always the case. In fact, it was a by-product of innovation i.e. risk, partnered with ineffective regulation within short-term debt and mortgages which led, in part, to the global economic crash.

So, haunted by the mistakes of 2008, financial regulators decided to introduce more stringent regulations to lessen the likelihood of a double-dip recession. But this is now leading to growing concerns and begging the question – is regulation stifling innovation within the financial services industry?

Regulation vs. innovation

The realisation that a lack of effective financial regulation was, in part, to blame for the global recession forced the hand of the government to both review the regulations it had in place, as well as to implement more stringent measures. But are these regulations now becoming a barrier to innovation?

There are those who believe that regulations which work to add pressure to business models by increasing the barriers to market entry are responsible for lessening opportunities to innovate. Barriers such as disproportionate de-risking, the faculty which denies businesses banking facility access, and capital requirements for new firms are often cited examples of regulation stifling innovation.

However, on the other side of the coin, there are those who instead argue that any regulation which promotes competition will act as an incentive for companies to invest capital in innovation – an example of this is pricing regulations. These regulations are also said to drive inclusion as they entice more and more companies to enter the market and to compete.

Further evidence of regulation fostering innovation can be found by looking at the UK’s introduction of its Electronic Money Regulations 2011. These delivered clearer and more stringent regulations within the e-money industry and are credited, at least in part, to helping cultivate the current success of the country’s fintech sector.

Promoting innovation

Earlier this month, the UK’s Competition and Markets Authority (CMA) published the findings of its retail banking market investigation, which found that older and larger banks don’t have to compete as hard for a consumer’s business. The CMA is now introducing a package of measures to ensure that banks work harder for consumers and better exploit new technology. A step in the right direction.

This isn’t to say though that the government and regulators haven’t been working hard to encourage innovation already. In October 2014, the Financial Conduct Authority (FCA) launched Project Innovate to bolster support for digital currency businesses by introducing measures to help support innovation. On top of this, the UK government has been making moves to improve the Current Account Switch Service (CASS), which aims to make it easier for consumers to compare current accounts and switch where better deals are identified.

Most recently, the government published its innovation plan with a heavy focus on technology. The plan looks at how technology is shaping the financial services industry, as well as how regulators can use new technologies (‘RegTech’) to create more efficiency savings.

So, is too much regulation stifling innovation?

Regulation is a multi-dimensional and complicated issue. And, its complexities are only further magnified by growing threats of money laundering, extortion and other fraudulent activities as means to fund terrorist and criminal activities. To combat these growing elements, regulators are continuously developing frameworks in an environment where sanctions and compliancy requirements are constantly changing, and changing quickly.

And yet, in spite of increasing regulations, the UK’s financial services industry continues to flourish, cementing its reputation as the world’s fintech leader.

These innovative businesses are coming at a time when frustrations with traditional banking continue to grow, as demonstrated in the findings of our latest research. Investigating as to whether banks are losing the innovation game, we found as many as half of the 2,000 survey respondents reported frustrations with their high street bank. These new, fresh-thinking and innovative young firms have seen a gap in the market and are taking the opportunities to provide an alternative to traditional banking, to fulfil the needs and wants of consumers.

Ultimately, we believe that a regulatory policy which maintains control whilst allowing some room for innovative risk will be most effective. Creating a balance between the two will bolster innovation further, help regain customer confidence with the financial services industry and will only further cement the UK’s status as the world’s leading fintech hub.

Scott Dawson is commercial director at Neopay, the market leading regulatory specialist in e-money and payments.